Daily Commentary - Posted on Monday, December 20, 2010, 7:11 PM GMT +1

13 Comments


Dec Monday 20

The Third Year of the Presidential Cycle

2011 will be the 3rd year of the so-called Presidential Cycle (made up of four years beginning with the year the president is inaugurated), which usually receives a good amount of publicity especially when it triggers a buy signal for the major market indices.

The fundamental reason why it shows an excellent track record might be that the markets usually perform worst in the year immediately following the election (the 1st year of the four-year cycle) as the new president shoulders any negative aspects of administering early in his term (during the 1st and 2nd year) while working to get the economy perked up timely in advance of the election year (during the 3rd and 4th year – the state of the economy on election day is regularly a major determinant).

This will be the first one in a series of postings checking for historical probabilities and odds concerning the 3rd year of the Presidential Cycle, this posting taking a more general view on historical occurrences and periodic returns in comparison to the market’s (S&P 500) at-any-time chances for closing out the week/month/quarter/half-year/year on a positive note.

Table I shows the date of the last session of the year (‘End-of-Year Day‘), the S&P 500′s historical (since 1930) performance (‘Annual Returns‘), the respective number of sessions (during the year), and the maximum gain and the maximum loss (drawdown) during the year for the 3rd years of all previous Presidential Cycles.


(* no close below trigger day’s close during period under review)

There hasn’t been a down year in the third year of a presidential term since 1939. In addition, downside potential was regularly limited. Since 1939 (the last 17 occurrences) the S&P 500 closed lower more than -10.00% below the previous end-of-year close at least once during the 3rd year on only 1 occurrence (-10.55% in 1947), but the index gained +10.00% or more at least once during the third year on 15 occurrences (and more than +20.00% on 9) out of the last 17 occurrences.

Table II below shows (and summarizes) the S&P 500‘s respective periodic returns and a couple of performance metrics (since 1930), broken down into a weekly, monthly, quarterly, semiannual and annual time frames.

It is interesting to note that

  • … although chances for a positive week (Weeks Positive in %) are only slightly better then the S&P 500’s at-any-time chance for a positive week, the median weekly gain of +0.46% significantly surpasses the S&P 500’s at-any-time median gain of +0.28% ;
  • … the longer the period under review, the better the S&P 500’s chances for a positive period are ; during the 3rd year, the S&P 500 closed out a quarter with a gain on more than 2 out of every 3 occurrences, the half-year on more than 3 out of every 4 occurrences and the year on 17 out of the last 20 occurrences (unchanged in 1947), with a median annual return of +18.08% (in comparison to an at-any-time median annual return of +9.66%).

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The logical next step is to look for the S&P 500’s historical performance for January of the 3rd year of the Presidential Cycle.

Table III shows the date of the last session of the month (‘End-of-Month Day‘), the S&P 500′s historical (since 1930) performance (‘Monthly Returns‘), the respective number of sessions (during the month), and the maximum gain and the maximum loss (drawdown) during January of the 3rd year of previous Presidential Cycles.


(* no close below trigger day’s close during period under review)

Although the number of occurrences is limited (naturally), it is at least interesting to note that

  • … the S&P 500 closed out the month with a gain on 17 out of 20 occurrences (or 85.00% of the time), thereof 16 out of the last 17 ;
  • … the S&P 500 posted a median weekly gain of +0.77%  (during January) in comparison to an at-any-time median weekly gain of +0.28% (figures not shown in the table) ; and
  • … the S&P 500 posted a median monthly gain of +4.01% in comparison to an at-any-time median monthly gain of +0.87% (figures not shown in the table).

Conclusions:

Right at the start of the next year, and in addition to the FED’s ongoing (daily) injection of liquidity, the market will get an additional strong tail wind by entering into the 3rd year of the Presidential Cycle.

To be continued …

Successful trading,

Frank

Disclosure: No position in the securities mentioned in this post at time of writing.

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Remarks: Due to their conceptual scope – and if not explicitly stated otherwise – , all models/setups/strategies do not account for slippage, fees and transaction costs, do not account for return on cash and/or interest on margin, do not use position sizing (e.g. Kelly, optimal f) – they’re always ‘all in‘ – , do not use leverage (e.g. leveraged ETFs), do not utilize any kind of abnormal market filter (e.g. during market phases with extremely elevated volatility), do not use intraday buy/sell stops (end-of-day prices only), and models/setups/strategies are not ‘adaptive‘ (do not adjust to the ongoing changes in market conditions like bull and bear markets).

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Disclaimer

The information on this site is provided for statistical and informational purposes only. Nothing herein should be interpreted or regarded as personalized investment advice or to state or imply that past results are an indication of future performance. The author of this website is not a licensed financial advisor and will not accept liability for any loss or damage, including without limitation to, any loss of profit, which may arise directly or indirectly from use of or reliance on the content of this website(s). Under no circumstances does this information represent an advice or recommendation to buy, sell or hold any security.

I may or may not hold positions for myself, my family and/or clients in the securities mentioned here. Actions may have been taken before or after information is presented, and any opinions expressed in this site are subject to change without notice.

(Data courtesy of MetaStock , and for data import, testing, surveys and statistics I use MATLAB from MathWorks)

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Comments (13)

 

  1. […] This post was mentioned on Twitter by Frank Hogelucht and Quant Blogs. Quant Blogs said: Trading the Odds: The Third Year of the Presidential Cycle http://bit.ly/f0sXHN […]

  2. Robbie Davis says:

    Mebane Faber wrote a recent post about combining the January effect with the Presidential Cycle. Can you run a test that substitutes the Russell 2000 and/or an appropriate microcap index for the SP500?

    • TradingTheOdds says:

      Robbie,

      thanks a lot.

      Yes’ I’m aware of Megan Faber’s posting, and my next posting will exactly deal with that: The Russel 2000’s performance in January, especially in the 3rd year of the Presidential Cycle (unfortunately the Russel 2000 was introduced 9/10/87, so there is a short history available only).

      Next posting will be published either today (12/22/2010) or tomorrow.

      Best,
      Frank

  3. Luis says:

    Hi Frank,

    This looks very promising for next year.

    Could you please comment on why you tend to use median over average returns?

    Many thanks and happy new year!
    Luis

    • TradingTheOdds says:

      Luis,

      the average return is very sensitive to any outliers on the upper and lower range (and may therefore distort ‘real’ probabilities and odds), while the median discounts the importance of numbers outside the data range.

      Best,
      Frank

  4. […] For all the bullish sentiment and the signs of extreme enthusiasm out there, the market does have the wind at its back. At least for several more months. In fact, since 1930, the last time there was a down year in this cycle was 1939 when the S&P 500 index lost 5.45%. Taking the short term view, the month of January in the third year of this pattern has also been very strong. The S&P 500 has historically shown a median weekly return of +0.77% in January, compared to +0.28% at any other time. For more historical data see this post at Trading the Odds. […]

  5. Alex says:

    One more hint to the valuable Frank’s work. Using data coming from the Stock Traders Almanac we could easily say that when the first 5 days in January, in a third presidential year, were positive on SPX (like in 2011) well .. in all cases (15 out of 15 since 1950) the S&P500 was positive at the end of the year. And in just 1 case out of 15 the positive performance, at the end of the year, was not in a double digit format. Meditate guys, meditate …

  6. milwaukeetraveler says:

    All stats aside, how do we figure in the current financial environment: $14 trillion debt, austerity measures embraced by countries like Spain, Poland, Italy- yet apparently not embraced by Obama, and Obama’s calls for additional deficit spending even after the S&P threatened to downgrade the U.S. debt rating? Don’t get me wrong- the historical stats appear to be in our favor for decent returns, but we (the United States) haven’t faced deficit spending to the proportions that we have now- on top of a weak economic recovery that certainly appears to be “jobless” in nature and a pant-load of uncertainty related to additional taxes and fees that we are just starting to learn about in ObamaCare. I’m keeping my fingers crossed as I’m not that far from retirement and my nest egg has some growing yet to do. Nonetheless, I’m still concerned….

  7. […] to 2011, 1991 was the third year of a first term President, the economy was suffering from the aftermath of an oil price shock and in the midst of a bank […]

  8. […] to 2011, 1991 was the third year of a first term President, the economy was suffering from the aftermath of an oil price shock and in the midst of a sever […]

  9. […] to 2011, 1991 was the third year of a first term President, the economy was suffering from the aftermath of an oil price shock and in the midst of a sever […]

  10. […] December of last year, we read a few posts suggesting 2011 would see above average returns for the S&P 500 since it was the third year of […]

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